The Economic Consequences of the Berlusconi Debacle

The Berlusconi debacle in the recent municipal elections in Milan, Naples, Turin and Bologna has been a veritable political earthquake that will destabilize the system of alliances that has governed Italy almost continuously from 1994. Simply put, there are two camps within the government: the party of rigor-despite-the crisis epitomized by the Minister of the Economy Tremonti and backed by the regional Northern League, and the party for less-taxes-more-development-of-the-south, which comprises the majority party, the Freedom Party, with Mr. Berlusconi sitting in the middle. So far he tilted towards Tremonti, but that may change. The second party loves to depict itself as “pro-growth”. Yet even children in Italy know that the reduction in tax rates, if unaccompanied by a massive effort to reduce tax elusion and evasion, estimated at 30% of total revenues, would compromise the budget consolidation efforts. This was reiterated yesterday by Mario Draghi, in his last speech as a Governor of the Bank of Italy. Mr. Draghi would not say, however, that such an effort to fight elusion and evasion is not politically feasible for the present government, since it would hurt its own supporters, small entrepreneurs in industry and services. Banning expenditure cuts and “structural” reforms of labor and product markets for similar electoral reasons, the much heralded “tax reform “ would lead the country to the dangerous path eventually ending in default. Similarly, spurring growth in the South hinges upon the eradication of organized crime, the worst distortionary tax on economic activity. Yet it is much it is easier for the “pro-growth” camp to boast about new Development Banks for the Mezzogiorno and large infrastructural projects. These would have no effect on growth, would fuel crime with public money and would likely destabilize the budget.

The recent government debacle comes at a time when the premier’s international image is badly damaged and the government’s majority in Parliament is very thin. The temptation for Mr. Berlusconi to back the low-tax-high-spending faction in order to bet on survival would be hard to resist. Thus, unless the Northern League pulls the plug and sends the country to the ballot boxes, as Bob Dylan may put it, a hard rain’s a-gonna fall.